Cashing out Your Pension

I hear it all the time. A person comes to see me, and tells me how someone (perhaps a friend or a so called investment advisor) suggested they cash in their pension when they retire. Oy vey. Please people, stop it already.

I have heard all the arguments why this is such a terrific idea. And I have seen all the tears when things don’t work out according to somebody’s overly optimistic plan. So lets recap.

Yes, when you leave a job, either quitting or retiring, you are often offered the opportunity to convert (or commute) your pension. This is where the first misunderstandings come into play. Yes, you can commute a pension. You can take the money in your company pension account, and put it into a Locked In Retirement Account (LIRA). A LIRA works similar to a RSP, except (1) it is locked in until you turn 55, (2) there are minimums and maximums that you can withdraw each year.

However, there are pitfalls which these so called friends and advisors neglect to either mention or give proper emphasis. Firstly, like an RRSP, your investments will be subject to market forces. So yes, you get to decide how it is invested, in stocks, mutual funds or GICs as you wish. And if they go down in value, like most investments did in 2008, you alone suffer the consequences.

Secondly, in Alberta, BC, Saskatchewan and Quebec, additional voluntary contributions you might have made in the past are not subject to creditor protection, and could be seized if you were ever sued. In Ontario, Quebec, New Brunswick, Manitoba and Saskatchewan locked in accounts are subject to garnishment for child support.

Thirdly, it is possible that not all of the money in your pension plan account will be eligible to be transferred directly to a LIRA. You may find that there will be a cash portion which will be paid directly to you, and you get walloped by income tax deducted from this amount at your top marginal rate. Peachy eh? Especially if you weren’t warned.

One of the things that really has people excited are rule changes in some provinces which will allow you to take up to 50% of your pension money in cash after January 1, 2010. Hooray! The government will then grab taxes from this amount at your top marginal rate. So if you live in Ontario you could lose up to 46.4% right off the top to the government. Dalton McGuinty  and Jim Flaherty will thank you.

My concerns with this whole process are many.

1. Canadian pension plans are generally well funded and regulated, and unless your company goes bankrupt, you will get all the money you are entitled to.

2. Canadian pension plan managers have shown better long term investment returns than the average RRSP investor. Especially Teachers, HHOOP, Hydro and many of the Union plans. Do you really think that you, as an amateur, can do better than the professionals who work in the business all day every day, who are able to utilize economies of scale and instant preferential access to the most up to date information when making their investment decisions?

3. In a defined benefit pension if there is a shortfall, the employer is on the hook to make up the difference. If your LIRA has a bad year, guess who makes up the difference?

4. If you take out 50% of your pension as a lump sum, what are you planning to live on when you retire?

Now, I know that you can never say never, and there are a few people for whom commuting a pension might actually be a good idea. However, they usually fit into certain limited categories.

A. You have multiple tiny pensions which individually will pay very small amounts every month. In this instance you may not suffer any great penalty by combining them and investing them as a unit.

B. You have a diminished life expectancy, no spouse, and wish your pension assets to go to your heirs. If you can make the argument that you will not live long enough, because of a pre-existing illness, to collect the bulk of your pension, then it might make sense to roll it over into a LIRA so that it can become part of your estate. However – big however – this will expose the entire pension to estate and probate taxes.

So exactly why are some people so quick to advise you to commute your pension?

First, is often the friend who read something someplace, and in whose hands a little knowledge is a dangerous thing.

Secondly, and most egregiously, is the so called advisor who assures you that he can put you into investments that will outperform the “pitiful” returns attained by pension plan managers. This guy is solely driven by commissions. Really, really big commissions. Thousands of dollars in commissions. Big, big, fat, juicy, buy a new Cadillac commissions.

Please don’t listen to these people. By the time you come to see me, I can’t fix it. I can’t correct the mess they have made. I can’t restore the long term value that they destroyed.


Filed under Estate Planning, Investing, Locked in Retirement Accounts, Mutual funds, Pensions, Saving

6 responses to “Cashing out Your Pension

  1. Pingback: Cashing out the Pension · MutualFunds.ExplainedOnline.Net

  2. Happy

    Would it be possible to declare non-resident status after settling away and than commute your pension? Would that be a 25%? Can you move lIRA, RRSP at the same rate?


    • This is a situation where advice from an international tax expert is appropriate. I am not a chartered accountant and hesitate to publish a definitive opinion in a public forum with having all the particulars in front of me. The best answer I can give right now is “it depends” and “maybe”. A large part of that answer is dependant on which country you are moving to, and what kind of tax treaty they have with the Canadian government. You must also be able to prove that you have cut all ties to Canada in a manner that CRA finds acceptable (they get nitpicky about this). You can cross all your T’s, and dot all your I’s and still find yourself on the receiving end of a nasty audit.

      I recommend seeking out a knowledgeable expert, which will probably mean talking to a tax lawyer or someone from one of the big accounting firms like Grant Thorton, KPMG or Deloitte. (Not George and Mary’s Tax Filing & Bookkeeping Service on Main Street.) You could phone CRA directly, but this question might be above the pay grade of the ones who answer the phones, in which case you could get 2 or 3 conflicting answers, all of which could be equally correct or equally wrong.

      The section of CRA’s website that pertains to your question is accessible at

      • Happy

        Thanks, I did read the page previously, it’s the may or may not, and we will tell you, causes lots of flexibility on CRA part to make life difficult. Worth spendning the cash to get the right country and advice or stay taxed forever.

  3. I want to retire early at age 50 (planning to move to a lower cost of living city and cash out the equity in my home). I have a defined benefit pension and will have 20 years vested at 50. Deciding between taking commuted value or deferring to claim a reduced pension at 55 years of age. The pension says I must take slightly more than 50% as cash payout and the rest as LIRA. I would prefer to have the entire sum as LIRA but they say they cannot do this. It seems unfair that the pension has not tax sheltered the growth of my funds. Are there any options to avoid the large cash payout in one year? I only have about 1/3 the cash value in rrsp room.

    • Hi Crystal – thanks for asking. I am afraid that the rules around commuting a pension are pretty well set in stone. The pension provider doesn’t have any discretion.

      You are lucky that you have been given complete and correct information. Yes, the tax penalty for cashing out is brutal, this is for a reason. The government would prefer that you have more money in retirement, and not have you rely on the Guaranteed Income Supplement. This is especially important for women, who statistically are more likely to live in poverty during their old age.

      Basically a pension’s tax structure is not so different from an RRSP. The money in the pension is allowed to grow tax-free until it is withdrawn. Then you are taxed on your monthly pension cheque at what is hopefully a lower rat then you were paying when you worked.

      This is why the fixed amount of your deposits are placed in a LIRA, and the income earned is taxed immediately (and painfully). The better quality of your pension, and te more income that the pension managers have earned on your behalf, the more tax you will pay.

      In a way that is good news. It means your pension is a good one, and you stand to benefit when you retire.

      If it was me, I might ask myself if that extra five years was worth throwing away a guaranteed monthly income. If it is, are there other ways to accomplish the same goal?

      Could you get a part-time job in your new town, and use part of the proceeds of the sale of your home to bridge the gap?

      You sound like you are a professional. Can you find a job that uses your current accreditation to do something new and different for that five year period?

      I would get some professional help to work through the numbers involved with the different options. Are you a member of a union that has retirement counseling? If not, I would seek out a certified financial planner who works on an hourly rate – NOT commission.

      You don’t need to rush your decision. Remember that nothing is set in stone until the day you sign those commutation papers.

      Whatever you do, please don’t throw away the future you worked so hard and long to earn. – Good luck!

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